Factors that affect the stock market

Written by kenneth hamlett

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Since its inception investors have wondered what factors affect the stock market. What factors contribute to the stock market’s performance? Certain economic indicators, financial news, world events and according to some, the phases of the moon, affect the stock market’s performance. Interest rates, inflation, supply and demand, human behaviour and news contribute to volatility and performance of the stock market.

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Interest Rates

Anyone with a credit card or loan clearly understands how he or she becomes personally affected by interest rates changes. But when rates change what effect does that have on the stock market? The market does not immediately become affected by a change in interest rates. The change happens slowly and trickles down to the market as a whole. The Federal Reserve (the Fed) charges borrowing banks the U.S. Federal Reserve’s federal funds rate (fed funds rate). The Fed uses this rate to curb inflation—caused when too much money enters the market and not enough goods and services get purchased. The Fed increased the rate to borrowing banks. Borrowing banks increase the rate to businesses. When businesses spend more on financing the company’s growth can suffer, in turn driving down the stock price. If enough companies experience these symptoms it can impact the stock market as a whole.

Human Behavior

In 1942 Sidney Wachtel wrote a paper outlining the abnormal performance the stock market sees during the month of January. Year-after-year the market enjoys bigger gains in January than during any other time of the year. He called this the January effect. Numerous studies have tried to reconcile the January effect with existing economic variables. His results indicate that human psychological behaviour could contribute to the January effect—violating the efficient markets theory. Wachtel concluded that the higher than normal returns achieved in January possibly arise from the “general feeling of good fellowship and cheer existing throughout the Christmas holidays…” In a 2005 research paper conducted by the College of William and Mary entitled, “Yes, Wall Street, There is a January Effect! Evidence from Laboratory Auctions”, the authors conclude, “Even after controlling for a wide variety of auxiliary effects, we find the same result. The January effect is present in laboratory auctions, and the most plausible explanation is a psychological effect that makes people willing to pay higher prices in January than in December.”

News

Good and bad news both affect the stock market and sometimes bad news has a positive effect. Corporate layoffs immediately increase company earnings and have a positive effect on a corporation, but when too many companies experience layoffs at the same time it creates a drop in the market as a whole. Market scandals such as the Enron scandal have a negative effect on the market. Positive news from world leaders has a positive effect on the market, but news of war and decreased supply of goods and services has a negative market effect.